Will Solar Power Remain Profitable in 2014?

Will the profitability of solar panels manufacturers decline in 2014? And how will this affect their shares?

The staggering rise in the consumption of solar power in the U.S. has provided a tailwind for shares of solar panels manufacturers including First Solar (NASDAQ:FSLR) and SunPower(NASDAQ:SPWR). These companies are likely to face stronger competition, however, which could cut down their profitability and impede their progress. Let's further explore these issues.

Outlook for 2014According to the Energy Information Administration, the demand for solar power is expected to reach 0.425 quadrillion Btu -- this represents a 34% jump compared to 2013. Among all other renewable energy options, solar power will present the highest gain. Nonetheless, solar power will still represent less than 5% of total renewable energy consumed. Therefore, even though the solar sector is growing very fast, it will still account for a small portion of the U.S renewable energy market.

This expected rise in demand for solar power will translate to higher number of solar panels installed. Case in point, the EIA estimates consumption of solar power grew by 36% during 2013. Further, the Solar Energy Industries Association estimates, 751 MW of new photovoltaic (PV) capacity was installed during 2013 -- this comes out to a 41% rise, year over year. This growth is also likely to benefit solar power companies.

According to First Solar's recent guidance for 2014, the company expects to increase its sales by over 16% year over year. SunPower projects its revenue will be roughly $2.55 billion -- less than a 2% gain over 2013.

These developments are likely to increase the competition and bring the price of solar panels down. According to the Solar Energy Industries Association, the average price of a photovoltaic installed system dropped by 15% during 2013. This trend is likely to persist as competition intensifies. A decline in prices could also lead to lower profit margins. SunPower projects its 2014 gross margin will reach an average of 20% and could fall as low as 19%. Back in 2013, this margin was 20.4%.

First Solar's gross margin is projected to drop from 26% in 2013 to around 17% in 2014. This could partly explain the company's lower than expected earnings per share guidance for 2014, which is between $2.2 and $2.6 per diluted share. In comparison, last year, First Solar's EPS was $3.7.

Both companies expect to see a decline in their profit margins during 2014. Nonetheless, both companies still expect to increase their capital expenditure during 2014. First Solar's capital expenditure is expected to range between $300 million and $350 million; back in 2013 its capex was $282 million. The company also has a war chest of more than $1.3 billion in cash, so a liquidity problem isn't likely to be an issue anytime soon. Even if First Solar's operating cash flow contracts in 2014, this won't force the company to cut down on its capex.

SunPower also expects to increase its capex to $160 million. Last year it was only $34 million.

Final noteSolar power consumption is likely to keep rising precipitately in the coming months. But the ongoing decline in prices and stronger competition could slash the profitability of solar panel manufacturers. Therefore, these developments could reduce the valuation of solar panels companies and their appeal as an investment.

Author

Lior has been a contributor for the Fool since 2012. His main interests are in commodities, and energy and materials companies.You can follow him on Twitter to stay up to date with his industry analysis. @tradingnrg